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The Cornerstone Investment Commentary: 3rd Quarter 2015

This was an ugly quarter! Concerns that global economic growth was slowing caused stock markets around the world to fall into the ‘red’ for the year and producing a ‘correction’ – a decline of at least 10% from Spring’s high points.

The real concern is that corporate profits, the market’s biggest driver, will fail to meet expectations due to slower consumer spending. (Perhaps surprisingly, it is not how or when the Federal Reserve may act.) This is because consumer spending is by far the biggest component (~70%) of economic activity, and businesses need their ‘sales’ to increase in order to grow their profits So, especially after 6+ years of almost entirely positive stock market returns, it wasn’t unexpected to see those parts of the world with larger slowdown fears – overseas – and where stocks were most highly-valued – U.S. small companies – declined the most. Often when volatility increases, the pendulum swings too sharply before reversing course; this may well be the case. When stock markets fall, it’s usually the highest quality bonds that provide the most shelter, and your bond holdings were designed in just this way. As a result, and also because we had previously lowered your stock market exposure by about a tenth, your portfolio has weathered this correction better thus far than had we not taken these steps.

Specifically, defensive strategies and U.S. large company stocks (your portfolio’s largest equity component) held up best this quarter – followed by stocks in developed foreign countries and U.S. small companies; foreign emerging markets fared the worst (though they have risen over 5% so far in October, reflecting their attractive price levels). Real estate recovered a bit after last quarter’s decline, and commodities continued their plunge, having now fallen nearly 40% since we eliminated them over a year ago.

Overall, we believe your portfolio is well-positioned given today’s levels of interest rates, inflation and the still-high market valuation levels in the U.S. That said, there are three beneficial steps we can evaluate in an environment like this: 1) Look for rebalancing opportunities, as we normally do, that allow us to add to ‘under-weighted’ equity categories; 2) Do so in ways that create tax advantages for you where possible; and 3) restore some of the equities we reduced several years ago should markets drop more than 20% from their Spring 2015 highs to more fairly-valued levels (which would occur if the Dow Jones Average fell to 14,500 and/or the S&P 500 dropped to 1,700).

Should any of our thoughts change on these items or due to even more volatile conditions, we will certainly act accordingly and be in touch. As always, we both welcome and look forward to any thoughts or questions you may have. And all of us at Cornerstone wish you a wonderful season of holidays with those you treasure most and thank you sincerely for the continuing opportunity to work together.